Is The Party Over For Southwest Airlines?

| About: Southwest Airlines (LUV)

Summary

Low jet fuel prices improved profit margin.

Increasing plowback resulted in improving growth.

DuPont ROE says Southwest Airlines is on the right track.

Do you feel that the party is over for airlines including Southwest Airlines?

The price per share of many companies in the airline industry increased substantially after 2012-2013. The stock of Southwest Airlines (NYSE: LUV), one of my favorite airlines, rose from $8.xx to $44.xx in 4 years, providing a handsome return to investors.

Jet fuel is one of the largest expenses incurred by airlines as well as salaries. Therefore, an important event that boosted airlines' profits was the sharp decline in crude oil prices. The World Bank believes that crude oil prices will remain below $50.00 during 2016 and that the price recovery will be slow in the interim, Figure 1. At least, the hike in expenses for airlines will be gradual provided that the forecast by the World Bank proves true.

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Figure 1

Southwest Airlines' recent stock performance

Recently, Southwest Airlines' stock fell 10% after the Q2 2016 earnings report. This price action seems a bit exaggerated and I decided to perform a DuPont ROE analysis to measure the company growth during Q2 2016 compared to the same quarter a year ago to determine whether or not this dip provides a good entry point for a long position.

DuPont ROE analysis

Table 1 summarizes the financials used to construct the DuPont ROE for the Q2 since 2013 until today. For simplification purposes, assets and equity represent the value at the end of the quarter as opposed to the average. Nonetheless, this simplification does not impact results significantly.

Q2

Net Income

Pre-Tax Income

Operating Income

Sales

Assets

Equity

2016

$ 820

$ 1,304

$ 1,276

$ 5,384

$ 22,477

$ 7,821

2015

$ 608

$ 977

$ 1,085

$ 5,111

$ 21,075

$ 7,158

2014

$ 465

$ 746

$ 775

$ 5,011

$ 20,891

$ 7,516

2013

$ 224

$ 363

$ 433

$ 4,643

$ 19,382

$ 6,781

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Table 1

As observed in Table 2, profit margin improved constantly from 9% in Q2 2013 to 24% in Q2 2016 while the tax burden, interest burden, turnover and financial leverage remain constant. This resulted in an improved Return on equity from 3.30% to 10.48% over the same period. It seems that Southwest's management is confident in its projects because the plowback ratio is increasing. An improving plowback ratio coupled with improving ROE results in a growth of 9.68% for Q2 2016, Table 3.

Furthermore, since the plowback ratio is very high, there is plenty of room for dividend distribution hikes in the interim.

Q2

Tax Burden

Interest Burden

Margin

Turnover

Financial Leverage

ROE

2016

0.63

1.02

24%

0.24

2.87

10.48%

2015

0.62

0.90

21%

0.24

2.94

8.49%

2014

0.62

0.96

15%

0.24

2.78

6.19%

2013

0.62

0.84

9%

0.24

2.86

3.30%

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Table 2

Q2

EPS

Dividend

Plowback

Growth

2016

$ 1.30

$ 0.100

92%

9.68%

2015

$ 0.91

$ 0.075

92%

7.79%

2014

$ 0.67

$ 0.060

91%

5.63%

2013

$ 0.31

$ 0.040

87%

2.88%

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Table 3

In brief

Southwest Airlines has grown steadily over the past four years, the ROE is increasing due to improving margins perhaps caused by low jet fuel prices. Although the crude oil price is estimated to increase over the next few years, the increment will be slow. Therefore, the current dip in LUV's price per share provides an excellent opportunity for a long position.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.